Google Abandons Its Chinese Search Engine... But Not the Chinese Market

Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google has "effectively ended" the development of its "Dragonfly" censored search engine for China according to The Intercept. After internal clashes Google reportedly shuttered the internal platform, which was pulling data from the Chinese site 265.com to create the search engine.

The end of the project wasn't surprising -- its revelation in early August sparked a public outcry, protests from employees, and tough questions from a House judiciary committee. However, Google CEO Sundar Pichai repeatedly defended the project, noting that the company often alters its search engine to conform with different countries' laws.

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But China is different

However, China remains a controversial market due to human rights and censorship issues. Google previously operated a search engine in mainland China, but shut it down in 2010 after discovering that the government had hacked Gmail accounts belonging to human rights activists across the country.

Google controlled over 40% of China's online search market at the time of its departure, putting it in second place behind Baidu (NASDAQ: BIDU). Google's exit enabled Baidu to comfortably conquer the market.

For now, Google probably believes that the PR fallout from "Dragonfly" outweighs the potential benefits from returning to China's 800 million internet users. However, despite that setback, Google still has plenty of other ways to retain a presence in the Chinese market.

How Google stayed relevant in China

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Google shuttered its mainland search engine, but its uncensored version in Hong Kong remains online. It still retained smaller offices in Beijing, Shanghai, and Shenzhen -- which focus on online ads and R&D -- expanded its hardware operations in Shenzhen, launched a new AI research lab in Beijing, and partnered with Tencent (NASDAQOTH: TCEHY) with a patent cross-licensing deal.

Google also stayed active in mobile apps with its Translate and Files Go apps, as well as a "mini program" for Tencent's WeChat, the top mobile messaging app in China with 1.08 billion monthly active users. Google also invested $550 million in Tencent's e-commerce partner JD.com (NASDAQ: JD) to bolster its Asian e-commerce presence in China and Southeast Asia.

Google believes that Chinese internet users still crave a viable alternative to Baidu, which controls nearly 70% of the country's search market. An August poll run on Weibo supported that notion, with 72.8% of respondents stating that they would use Google if it returned to China, compared to 21.7% who preferred Baidu and 5.5% who said that "both were fine."

How much money is Google walking away from?

Baidu is expected to generate about $15 billion in revenue this year. If Google can capture just 10% of China's search market again, it might generate about a seventh of Baidu's revenue (which mostly come from ads) -- which would equal about $2 billion.

That amount would be a drop in the pond for Google, which is expected to generate $136 billion in revenue this year. However, relaunching its search platform in China could enable Google to expand to China's other higher-growth adjacent markets, like e-commerce, smart retail, fintech services, cloud services, AI platforms, or driverless cars.

However, it's highly unlikely that Google will reclaim 40% of the country's online search market again without a fight, since the rest of the market is split among entrenched players like Alibaba's Shenma and Tencent-backed Sogou, which control 16% and 6% of the market, respectively.

Moreover, my estimate of $2 billion for a 10% market share might be too rosy, since it assumes that Google has the same pricing power as Baidu, the country's 800-pound gorilla in online advertising. Marketers might be reluctant to buy ads on Google again after its abrupt departure eight years ago, so Google could need to sell its ads at much lower prices than Baidu to grow its market share again.

This story isn't over yet

Google's decision to scrap "Dragonfly" won't end its efforts to serve Chinese users. It will continue working with Tencent and JD to grow its mindshare among the country's mobile users and e-commerce shoppers, which could keep its brand relevant even as Baidu dominates the online search market.

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